Typically, all around the world, investors tend to have too much exposure to their own market – the market you know best is the easiest to invest in. For example, many investors in Italy hold too many investments in Italian-based companies. Same thing can be said for investors in the UK who hold way too many investments in UK based companies. Same situation applies to every country.
Statistics show that if you have a well-diversified portfolio of investments, you’ll often achieve better returns. Different assets or regions will perform differently, and can often vary significantly year to year. The diversification that comes with this varied performance can help reduce the risk of having all your assets drop at once.
Diversification in various asset classes is important and is considered one of the major cornerstones of investment management. It is a key investment strategy for the preservation of wealth and helps to manage and mitigate the risk of any one asset type underperforming over time.
Different asset classes have different risk/return trade-offs and these become more evident to you during the process of determining your preferred investment asset allocations vs income/growth needs.
Diversification can also be achieved by spreading not just in various asset classes, but also across different geographical regions, sectors and currencies. In this way you are ensuring not to be over exposed to any given asset type, country, sector or stock. At the same time the aim is to provide the highest potential return for your risk profile.
The chart below is showing the returns of various asset classes over the past fifteen years. What this clearly highlights is that assets tend to perform differently in various time frames as they are affected by political, economic, financial and market risks at that particular time.
You’ll see that assets classes perform erratically from year to year. And asset classes that are the best performer one year can become the worst performer the following year.
What’s the solution?
It is very difficult to predict the best performing sector year to year. Hence, it is therefore imperative to have a portfolio holding a balanced mix of investments in order to smooth out the volatility and maximise your reward with the lowest possible risk.
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